There are two things investors pay too much attention to, according to Jennings Capital Analyst Dan Hrushewsky: metals prices and grade. Why? Extremes of low and high prices never last, and high grades don't always make for economic deposits. In this interview with The Gold Report, Hrushewsky explains the metrics behind his all-in cash cost estimates.
The Gold Report: So far in 2013 we've seen steep one-day drops in metals prices and seemingly endless redemptions in gold exchange-traded funds [ETFs]. Is the gold bear here to stay?
Dan Hrushewsky: Interesting question. Bear markets never last forever, and being roughly two years into this one, I would say that we are closer to the end than the beginning. It is difficult to say how far away we are from the end. We may be seeing the first signs of life. You'll recall that during the last bear market in the late 1990s and early 2000s, signs of life began showing up in the diamond sector first. It's almost as if investors still had a bad taste in their mouth from the traditional gold and base metal sectors, but started feeling comfortable with risk again and started with a different "flavor." We could even be starting to see this in the uranium sector with some of the juniors active in the Athabasca Basin.
TGR: Some mines aren't profitable at $1,250 per ounce [$1,250/oz] gold. How are companies adjusting to the new price environment for gold?
DH: Recently, a lot of companies have been talking about: 1) cutting head office costs, 2) renegotiating contracts with third parties, 3) deferring capital expenditures [capex], cutting down on sustaining capex and deferring pre-stripping, 4) re-sequencing mine plans to access higher grades first, 5) re-calculating resource estimates at higher cut-off grades, reserve estimates at lower gold prices and 6) suspending, closing or divesting of higher-cost assets.
TGR: Are mines operating in West African countries typically higher margin?
DH: Not necessarily. It depends on the specific characteristics of the deposit, such as grade and metallurgy, and access to infrastructure, such as cheaper hydroelectric power and water. High-margin projects are strong performers in high or low gold price environments.
TGR: What are your near-term and medium-term prices for gold?
DH: I use a near-term gold price similar to current levels, and a long-term gold price of $1,500/oz. I don't use lower gold prices in the long term, because if you use steady state lower prices you have to assume a lower-cost structure, and you have to assume different mine plans and different resource/reserve estimates [i.e., smaller reserves/resources at higher grades]. Making these detailed adjustments in my model just doesn't make sense.
TGR: As an analyst, are you shifting your focus to low-cost producers? Perhaps some equities operating high-grade underground mines or open-pit, heap-leach operations?
DH: Most of the companies I cover are attractive depending on your gold price outlook. For example, if you think gold prices are going up, you would want to own companies with high leverage to gold price increases. If you think low gold prices will be around for a long time, then the companies with high-margin projects are optimal investments. Of course these latter companies do well in rising gold price environments as well.
TGR: Many of the companies you cover are either exploring or mining in West Africa. In a risk-averse market, why would an investor in junior equities want to be vested in West Africa versus somewhere like Mexico?
DH: Because I find that the West African companies are a better value than companies elsewhere due to perceived higher risk. I say "perceived" because I believe that many places in, for example, Mexico, are higher risk than many West African countries. I also believe that the potential for exploration success in West Africa is better due to relatively less previous mining activity there.
TGR: How does an investor mitigate risk while getting exposure to African plays?
DH: By choosing companies with good management and higher-quality, advanced projects in good jurisdictions, such as Asanko Gold Inc. (NYSEMKT:AKG) .
TGR: To conclude, when it comes to junior gold equities, what is one thing investors put too much emphasis on and one thing investors pay too little attention to?
DH: Investors put too much emphasis on the gold price [extremes of low and high gold prices never last], and grade [high grade on its own does not always make a deposit]. They put too little emphasis on grade continuity [isolated high-grade drill results are meaningless-you need the dots to connect and a lot of them] and costs [you don't put grade in the bank; you put the difference between the gold price and the cost]. Also, you need to take into account all the costs. My all-in cash costs include the direct mining and milling costs, royalties, sustaining capital, taxes, corporate general and administrative expenses and financed amortized capex.
TGR: Thank you for your time.
This interview was conducted by Brian Sylvester of The Gold Report.
Dan Hrushewsky, senior precious metals analyst at Jennings Capital, is primarily responsible for African precious metals. He joined Jennings Capital in Toronto from NCP Northland Capital Partners, and was previously senior vice president, corporate development with Chalice Gold Mines and vice president of High River Gold. Hrushewsky has nearly 30 years of experience within the mining sector. Hrushewsky holds an engineering degree from the University of Toronto, a Master of Business Administration degree from McMaster University and is a CFA.
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